Question

2. Assume that banks hold no excess reserves and the nonbank public does not change its holdings of currency when the monetary base changes. If the Fed sells $800,000 in government securities to a member bank and the reserve requirement is currently 10%, what is the effect on the level of deposits in the economy?

Answer 1

Answer - The reserve rate = 10 percent

Amount for which the securities are sold = $ 800000

Since the securities are sold , this would reduce the supply of money in the economy. The amount by which the supply will be reduced is as follows -

800000 * 1/10

= $ 8000000.

Thus the money supply will be reduced by 10 times the amount received by fed after the sale of the securities. This will have a contractionary effect on the money supply of the economy and the lending of the banks will reduce leading to the higher interest rates and thus lower investments